BLACKBOARD ELASTICITY HANDOUT - Econ 306 Intermediate Micro...

1 Econ 306 Charles Hulten Intermediate Micro 1106C Morrill CLASS HANDOUT #1 ARC ELASTICITIES Consider the following example in which there are two goods, Y and X, and prices and income are P X = $10, P Y = $10, and I = $1000. Faced with these data, a consumer maximizes utility by choosing the point e 1 in the top figure on the last page. This is the tangency of the budget constraint and the highest attainable indifference curve, and leads to X = 70 and Y = 30. Suppose, now, that the price of X quadruples, so that P X = $40, P Y = $10, and I = $1000. This rotates the budget constraint from the original position, B 1 , to the new position B 2 , and the consumer now chooses e 2 ; at this point X = 10 and Y = 60. This information can be represented in terms of the following table: I Y X P Y P X $1000 20 70 $10 $10 $1000 60 10 $10 $40 This information can be represented in terms of the following demand curves: when the price of X quadruple, the consumer move up his demand curve for X from e 1 to e 2 . The demand curve for Y shifts outward, while the price of Y

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